Keith Savard
Adjunct Fellow
Banking and Capital Flows and Capital Markets and Finance and Global Economy and Public Policy and Systemic Risk
Keith Savard is a fellow at the Milken Institute. He has extensive executive management experience with expertise in evaluating the interrelationship between economic fundamentals and activity in global financial and commodity markets. He also has a background in sovereign risk analysis and applying a disciplined economic approach to investment-portfolio decision-making.
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All Eyes Once Again on the Federal Reserve

By: Keith Savard
September 15, 2015

With all eyes focused on the Federal Open Market Committee (FOMC) meeting this week and whether or not the target for the federal funds rate will be raised, market participants are trying desperately to better understand possible influences on the decision making process. The Federal Reserve did its best during a period of exceptional monetary measures to alert market participants through the use of “forward guidance” about its intention to return to normalization. This resulted in every adjective and adverb being analyzed in each FOMC statement for clues as to when this might occur.

The Federal Reserve ventured a step further than its written statements when Chair Janet Yellen said in July that a decision to raise the federal funds rate would be “data dependent.” However, interpreting data can be as difficult as parsing the language of Federal Reserve statements. A strong case can be put forth that recent GDP and other output data, as well as labor market indications, support a decision to begin raising policy interest rates. However, weak data on wages and inflation suggest that a cautious approach might still be warranted.

The angst over whether or not the Federal Reserve will pull the trigger on a rate increase raises the question of what else might the governors and reserve bank presidents be considering. Obviously, the recent turmoil in the Chinese equity market and the continuing weakness in commodity markets along with the strength of the U.S. dollar immediately come to mind. The short-lived correction in the U.S. equity market might also have appeared on the radar screen of FOMC members. Although these events have been important to both institutional and retail investors, it is unclear if any of this will influence actual voting. Fed officials have been quite cagey over the years when discussing asset prices, preferring to stay removed from the to and fro of market activity. In contrast, the Federal Reserve always has been straightforward in saying that the U.S. Treasury is responsible for policy involving the dollar.

With all the attention and associated drama surrounding this week’s FOMC meeting, it is interesting to speculate if any of this will having a bearing on Thursday’s decision. While one would hope that the voting members would do their best to rely on professional judgement, it could be the case that second-guessing comes into play in response to all the warnings and hyperbole which have arisen in recent weeks. Heavy-weight institutions like the IMF and World Bank have urged the Federal Reserve not to raise rates at this time. The chief economist of the World Bank went so far as to publicly state that the Fed risks triggering “panic and chaos” in emerging markets if it lifts interest rates. In addition, several high-profile investors have warned that a rate hike now would open the lid on Pandora’s Box and could throw the global economy into recession or possibly worse. Hey, is there anything wrong with trying to jawbone the Federal Reserve to enhance one’s portfolio positions?

So what will the Federal Reserve do? In all likelihood voting FOMC members will do their best to block out extraneous noise and focus on the institution’s mandate to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates. While there is some uncertainty as to the strength and sustainability of economic activity, history has shown that acting too slowly in raising rates has been costly in terms of fighting inflation and maximizing employment. As Fed Vice Chairman Stanley Fischer recently alluded, there is no inherent benefit in waiting to decide on a rate hike.

Indeed, a move toward normalization of monetary policy could boost confidence that financial markets and the real economy have finally escaped the shadow of the financial crisis and Great Recession. Although more work needs to be done to temper overreaction on the part of legislators in addressing issues of systemic risk, a hike in the federal funds rate would send an immediate strong signal that the central bank is doing its part to restore normal pricing in financial markets. Hopefully, this will contribute to reducing possible future systemic risk that could be exacerbated if excessively lax monetary policy were to continue.